California’s Franchise Tax Board (FTB) and other state taxing agencies—such as the California Department of Tax and Fee Administration (CDTFA)—watch certain deductions and credits closely for potential abuse. While many deductions are entirely permissible if adequately documented and consistent with California state law, overaggressive or unsupported claims can invite serious scrutiny.
At the Tax Law Offices of David W. Klasing, we understand that certain deductions—when claimed too aggressively or without proper documentation—can trigger California tax audits, potentially leading to significant back taxes, penalties, and even, in worst-case scenarios, criminal tax exposure. Our nationally recognized team of dual-licensed Tax Attorneys and CPAs has nearly three decades of combined experience, specifically in defending clients against audit triggers arising from questionable deductions. We work closely with you to ensure that every deduction you claim, from home office expenses to charitable contributions and business travel, is fully supported by robust documentation and aligned with industry norms. Our proactive approach helps to minimize your tax liability while safeguarding your rights, ensuring the FTB or other California state tax agencies do not unfairly target you. If you have concerns that your deductions may have raised red flags or if you’re already facing a high-risk audit, call the Tax Law Offices of David W. Klasing at (888) 564-1409 or contact us online for a reduced-rate initial consultation and let our experienced team help you navigate the complexities of federal and California tax law with ease.
Why Certain Deductions Draw Additional Attention
California state relies significantly on personal and business income taxes, as well as sales and use taxes, to fund state programs. Consequently, the state dedicates considerable resources to detecting overstated deductions. Returns that deviate from established norms or contradict third-party data often land on the FTB’s radar:
- Significant Revenue Impact – Deductions that markedly reduce taxable income, such as significant charitable contributions or substantial home office write-offs, are more likely to prompt further inquiry.
- High Likelihood of Error or Abuse – Complex deductions (e.g., business meals, entertainment, hobby versus business losses) frequently generate mistakes or misuse.
- Data Matching & Cross-Referencing – The FTB regularly compares forms, including 1099s, W-2s, and 1098s, against your return. Disparities can lead to deeper examination.
A Word on Overstating Deductions: Criminal Tax Implications
It is illegal under federal law to willfully overstate deductions with the aim of evading taxes, and California state law likewise punishes fraudulent filings harshly. Courts have held that repeatedly inflating deductions can constitute tax evasion. In United States v. Trevino, 394 F.3d 771, 777-78 (9th Cir. 2005), for example, the taxpayer was found guilty of evasion after systematically claiming charitable contribution deductions that never reached the charity. Similarly, the Eighth Circuit in Zacher v. U.S., 227 F.2d 219, 224 (8th Cir. 1955), stressed that “a consistent pattern of overstating deductions” is tax evasion—even if taxpayers later try to argue that later-year losses should ‘cancel out’ earlier overstated deductions, as Willingham v. U.S., 289 F.2d 283 (5th Cir. 1961), confirmed. Once the fraudulent deduction is claimed, the crime is effectively complete for that year, and future losses cannot retroactively justify the original false statements.
Common Deductions the FTB Monitors
Home Office Deduction
When taxpayers claim a home office, the Franchise Tax Board (FTB) often examines whether the space meets the “exclusive and regular use” requirement. If the portion of utilities, mortgage, or rent attributed to the home office appears disproportionately large compared to your total income, that discrepancy can raise questions. Many filers unknowingly fail the exclusivity test by mixing personal and business use in the same space. To avoid scrutiny, it is vital to maintain detailed documentation, such as monthly utility statements, usage logs, and floor plans, demonstrating that the area is strictly used for business. Any evidence of personal or family activity in that workspace can lead to a reduction or disallowance of the deduction.
Large Charitable Contributions
High or unusual charitable donations—especially noncash gifts like vehicles, artwork, or collectibles—are subject to increased scrutiny by the FTB. Overstated values, missing appraisals, and insufficient receipts commonly trigger audits. If you donate items of significant worth, make sure to secure a qualified appraisal or credible market data reflecting the fair market value. Always obtain contemporaneous receipts from the organization detailing the donation date, item description, and value. By aligning your claimed contribution with the charity’s records, you reduce the risk of an inquiry into the legitimacy of your donation.
Business Travel and Meals/Entertainment
Although federal law has tightened restrictions on entertainment deductions, California sometimes permits certain business-related expenses, making them a likely focal point for FTB examiners. Vague or lavish spending reported as business costs can raise red flags, prompting the FTB to demand evidence of a direct business purpose. The best defense is to keep comprehensive logs that detail the event date, participant names, and location—along with credible receipts matching those statements. Any mismatch in credit card statements or a lack of a legitimate business rationale may result in a disallowed deduction and potential penalties.
Schedule C Losses (Self-Employed Filers)
Self-employed Californians repeatedly reporting substantial Schedule C losses risk inviting closer inspection. The FTB may question whether the purported business is truly profit-oriented or instead a hobby used to offset other income. To defend your deductions, maintain clear evidence of genuine attempts to generate revenue, such as marketing expenditures, client outreach, and revenue forecasts. Commingling personal and business expenses is another common pitfall. Keeping separate bank accounts and accounting software for your business helps establish the legitimacy of your operations.
If you have a pattern of utilizing fraudulent Schedule C losses on nonexistent businesses to offset W2 wages do not attempt to handle any related federal or California audit with the original preparer or anyone that is not trained in criminal tax defense.
Mortgage Interest and Property Taxes
In high-cost California markets, interest and property tax deductions can be sizable. The FTB cross-references Form 1098 data from lenders and local tax records to detect inconsistencies, such as inflated amounts relative to your reported income. To stay compliant, verify that your mortgage interest and property tax claims accurately match the lender’s statements and fall within allowable thresholds for first or second homes. Discrepancies can lead to audit inquiries or adjustments.
Medical and Dental Expenses
Although California broadly follows federal guidelines allowing medical and dental deductions above a certain percentage of adjusted gross income (AGI), unusually large or sporadic deductions can prompt additional questions. Substantiating these claims with invoices, insurer statements, and proof of actual payment is essential. Also, verify that you exceed the mandated AGI threshold for the year, as an easy mathematical mistake might trigger further review.
Sales/Use Tax Exemptions and Credits (CDTFA)
Overseen by the California Department of Tax and Fee Administration (CDTFA), sales and use tax exemptions or credits can indirectly lead to FTB scrutiny if the exemption amounts appear unjustified or disproportionately large. For instance, claiming a manufacturing equipment exemption or certain green-energy incentives can be valid but requires in-depth documentation. Ensuring consistent reporting across CDTFA filings and your state income tax returns is crucial to avoid conflicting information that might spark a broader audit.
Can Certain Tax Deductions Make Me a Target for an Online Business Tax Audit?
Many business owners—particularly those operating e-commerce or other online ventures—worry that claiming particular deductions or credits might heighten their chances of being audited. While it may be tempting to forego certain write-offs to appear less “risky,” overpaying your taxes for fear of an audit is usually unwise. You’re entitled to every lawful deduction you can substantiate, so long as you:
- Maintain Adequate Documentation
- Whether deducting startup costs, depreciation on equipment, or marketing expenses, keep receipts and logs verifying each expense is business-related.
- Reflect a Genuine Profit Motive
- If your online enterprise shows losses year after year—potentially offsetting other income—be prepared to prove you’re running a legitimate for-profit business, not a hobby or sham tax shelter.
- Remain Consistent with Industry Norms
- Claiming deductions that are out-of-step with comparable online businesses might flag your return for an audit, especially if the claims appear inflated or inconsistent with known revenue streams.
How the Tax Law Offices of David W. Klasing Can Help
While many taxpayers might imagine themselves as too “small” or obscure to be caught, modern data analytics driven by Artificial Intelligence have dramatically increased the government’s capacity to detect discrepancies in returns. Once an auditor identifies potential “badges of fraud” (e.g., suspicious overstatements), they can escalate your situation to a criminal tax investigation. Historically, courts have made it clear that consistent patterns of overstating deductions can constitute felony tax evasion, punishable by prison sentences, hefty fines, and restitution.
Whether you’re a traditional brick-and-mortar or online entrepreneur, claiming deductions inevitably exposes you to potential high-risk federal and California tax audits—especially when those deductions appear abnormally large or are supported by inadequate records. Our dual-licensed Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing can assist with the following:
- Proactive Risk Assessments
- We’ll evaluate your existing tax positions, confirm they align with industry norms, and advise on compliance to minimize audit triggers.
- Audit Defense & Appeals
- If you’re already under audit, we safeguard your interests. From responding to FTB or CDTFA notices to coordinating appeals, we help ensure your rights are upheld and that no “badges of fraud” go unrefuted.
- Voluntary Disclosures
- If you suspect your tax returns have crossed the line—by omitting income or overstating deductions—coming forward before the IRS or California state agencies initiate an investigation can nearly guarantee relief from criminal tax prosecution and a reduction in civil penalties. Only an Attorney can guide you through a domestic or offshore voluntary disclosure without committing unauthorized practice of law. An experienced criminal tax defense lawyer leverages attorney-client privilege and work product protections to prevent them from being forced to testify against you, especially if they prepared or amended the problematic returns.
- Criminal Tax Defense
- In the unfortunate event that your case escalates to a federal or California state criminal tax investigation, our firm—consisting of extensively experienced Criminal Tax Defense Attorneys, Kovel CPAs and EAs —stands ready to fight for the best possible outcome. We know how to navigate high-risk “eggshell” or “reverse eggshell” audits and can effectively counter allegations of willful fraud.
Note: As long as a taxpayer self-reports tax fraud (including a history of non-filed returns) through a domestic or offshore voluntary disclosure before audit or prosecution begins, they typically obtain a near-guaranteed pass on criminal charges and often face reduced civil penalties. This underscores the importance of timely, informed legal advice if you have any concerns about past tax returns.
Call the Tax Law Offices of David W. Klasing at (800) 681-1295 or contact us online for a reduced-rate initial consultation. Our blend of legal advocacy and accounting proficiency provides a one-stop solution for handling everything from benign errors to high-risk felony tax defense. Whatever your situation—be it overshadowed by questionable deductions, fear of an audit, or a desire to come forward under voluntary disclosure—our firm is committed to protecting your finances, your business, and, ultimately, your liberty.
